Nanotech Security Announces Second Quarter Fiscal 2016 Results

Production and Delivery Commenced for Major Banknote

VANCOUVER, British Columbia – May 31, 2016 – Nanotech Security Corp. (TSXV: NTS) (OTCQX: NTSFF), (“Nanotech” or the “Company”) today released its financial results for the three and six months ended March 31, 2016. Unless otherwise stated, all dollar amounts are expressed in Canadian dollars.

Financial Highlights during the Second Quarter

  • Revenue of $948,000 driven by Security Features. Security Features contributed revenues of $645,000 largely from development contracts and Surveillance delivered $303,000, which was negatively impacted as four surveillance vans were not shipped until after quarter end.
  • Gross margin improved to 52% up from 47% in the same period last year. The improvement reflects the increased mix of higher margin Security Features revenue.
  • Cash balance of $1.1 million at end of Q2. Subsequent to the quarter, Nanotech completed a $3.0 million dollar secured credit facility to fund operations and working capital as production begins to ramp through the remainder of 2016.

Doug Blakeway, Nanotech’s Chairman and CEO, commented, “The second quarter was affected by the delay of four undercover surveillance vans. Our customer has subsequently taken delivery of these units, and we will see these revenues reflected in our third quarter results.” Mr. Blakeway added, “The second quarter also saw a lot of Nanotech’s resources allocated to bringing the Hueck Folien production facility online. We expect production to ramp up quickly and are confident that we will be able to deliver volume production for our Asian customer through 2017 and beyond.”

Recent Developments

To supply security feature for major new banknote. Nanotech has completed the rigorous supplier acceptance process and has commenced production and delivery of Nanotech’s proprietary colourshifting optical thin film (“OTF”) that will be used as windowed security thread in banknotes for a large Asian country. The OTF will be produced in co-operation with Hueck Folien, the Company’s licensed production partner. Production of the initial order has already commenced, and with successful delivery and acceptance, follow-on orders are anticipated. Production capacity is expected to ramp up through the summer, and we will be well positioned to supply this customer through 2017 and beyond. Due to the confidential nature of the supply arrangement, commercial terms were not released but the opportunity is expected to have a significant effect on Nanotech revenues. There are no long-term contractual purchase commitments at this time however it is expected that follow on orders will occur with the successful ramp-up of production and delivery.

Unsecured $2.5 million convertible debenture. Subsequent to the quarter end, the Company announced its intention to privately place approximately $2.5 million of unsecured senior debentures convertible into common shares at a price of $1.25 (“the Debentures”). The Debentures bear interest at 12% and come due May 31, 2018. The Debentures are subject to automatic conversion in the event that the common shares of the Company trade on the TSXV at or above $2.00 for ten consecutive days any time after the first four months from issuance. Insiders are expected to subscribe for $350,000 of the offering. Completion is expected in the third quarter. “I am extremely pleased that we have now completed the acceptance process with this important Asian customer and met its demanding specification requirements,” said Mr. Blakeway. “We believe we are well positioned to be a major supplier going forward.”

Strategic Highlights during the Second Quarter

  • Paid optical variable device development contract progresses. The contract was announced in February 2015 and calls for the incorporation of an optical variable device into future banknotes and is coming to a successful completion. Nanotech has already begun working with the customer to expand the scope in a future contract moving the Company closer to final selection for a major banknote.
  • Paid KolourOptik® development contract progresses. The three phased contract announced this past February 2016 calls for KolourOptik® technology on a banknote. To date, the development is proceeding smoothly and on course with Nanotech’s internal schedule.
  • Provided technology to authenticate tickets at UEFA EURO 2016® football championship. Nanotech’s KolourOptik® technology was chosen for admission tickets, due to its intense high definition (iHD) full colour imaging capabilities and anti-counterfeiting security features – replacing older hologram technology used at past events.
  • Award winning “regional banknote of the year” includes Nanotech’s OTF. The National Bank of Kazakhstan’s 20,000 Tenge banknote, which includes Nanotech colour-shifting OTF security feature, was awarded regional banknote of the year.

Selected Financial Information

Nanotech

All results are reported in Canadian dollars and are prepared in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board (“IASB”).

Revenues for the three months ended March 31, 2016 decreased by $580,000 to $948,000 compared to $1,528,000 in the same period last year. This included the Security Features division delivering revenue of $645,000 compared to $868,000 during the same period last year, primarily from development contracts. The development contracts continue to progress well and are advancing both our KolourOptik® and colour-shifting OTF technologies to be integrated into future banknotes.

OTF production continued to be negatively impacted as a large Asian issuing authority requested Nanotech sub-contract volume production through a partner relationship. On November 17, 2015 the Company announced the signing of a Memorandum of Understanding which contemplates an operational agreement with Hueck Folien to collaborate in the production of volume colour-shifting OTF. This integration has continued to consume internal resources in bringing the new manufacturing facility online. In May, subsequent to the quarter end, the Company completed the supplier acceptance process with the larger Asian issuing authority and commenced production and delivery of colour-shifting OTF through its licensed production partner Hueck Folien. Production is expected to ramp up volume through the summer and be positioned to supply this customer with significant colour-shifting OTF on a long term basis.

The Surveillance division achieved revenues of $303,000 for the three months end March 31, 2016 compared to $660,000 during the same period last year. This decrease reflected the delay in the shipment of four surveillance vans valued at approximately $220,000 that were unable to be delivered prior to the quarter end, but were shipped in April 2016.

Revenues for the six months ended March 31, 2016 decreased by $608,000 to $2,457,000 compared to $3,065,000 in the same period last year. This included the Security Features division delivering revenue of $1,214,000 compared to $1,910,000 during the same period last year, primarily from development contracts. The OTF production continued to be negatively impacted as the team focused on bringing the new production facility online. The Surveillance division achieved revenues of $1,243,000 for the six months ended March 31, 2016 compared to $1,155,000 during the same period last year. This modest increase reflected growth in the number of surveillance vans delivered during the period. Gross margin for the three months ended March 31, 2016 decreased by $225,000 to $493,000 compared to $718,000 in the same period last year. Overall, the gross margin percentage reached 52% for the three months ended March 31, 2016, an improvement from the 47% in the same period last year. This increase is reflected in higher margins on the Security Features division’s development contracts and Surveillance division sales.

Gross margin for the six months ended March 31, 2016 was $1,241,000, consistent with $1,246,000 in the same period last year. Overall, the gross margin percentage reached 51% for the six months ended March 31, 2016, an improvement from the 41% in the same period last year. This increase is again reflected in higher margins on the Security Features division’s development contracts and Surveillance division sales.

Research and development expenditures for the three months ended March 31, 2016 increased by $234,000 to $1,427,000 compared to $1,193,000 in the same period last year. This is primarily a result of an increase in depreciation and amortization of $253,000 reflecting a 2015 revision of the Company’s depreciation policy. Research and development activity for the three months ended March 31, 2016 continued to focus on bringing the new Hueck Folien production facility online and new security features targeted for the banknote market. Research and development expenditures for the six months ended March 31, 2016 increased by $467,000 to $2,743,000 compared to $2,276,000 in the same period last year. This is primarily a result of an increase in depreciation and amortization of $483,000 reflecting a 2015 revision of the Company’s depreciation policy. Research and development activity for the six months ended March 31, 2016 also continued to focus on bringing the new Hueck Folien production facility online and new security features targeted for the banknote market.

General and administration expenditures for the three months ended March 31, 2016 were $690,000, an increase of $158,000 compared to $532,000 in the same period last year which reflected higher office rent, overheads and an increase in stock based compensation.

General and administration expenditures for the six months ended March 31, 2016 were $1,349,000, an increase of $211,000 compared to $1,138,000 in the same period last year which again reflected higher office rent, overheads and an increase in stock based compensation.

Sales and marketing expenditures for the three months ended March 31, 2016 were $653,000, an increase of $114,000 compared to $539,000 in the same period last year due to increased sales and marketing activity related to the Security Features division, which includes increased salaries and international travel. Sales and marketing expenditures for the six months ended March 31, 2016 were $1,202,000, an increase of $298,000 compared to $904,000 in the same period last year was again due to increased sales and marketing activity related to the Security Features division, which includes increased salaries and international travel. The net loss for the three months ended March 31, 2016 was $2,450,000 compared to $895,000 during the same period last year. The increase in net loss is reflected in lower sales, an increase in sales and marketing activities, and an increase in non-cash amortization and foreign exchange. The prior year figures also include a $560,000 gain on the revaluation of contingent shares. The net loss for the six months ended March 31, 2016 was $4,196,000 compared to $1,826,000 during the same period last year. The increase in net loss is reflected in an increase in sales and marketing activities, and an increase in non-cash amortization and foreign exchange. The prior year figures also include a $1,160,000 gain on the revaluation of contingent shares.

The Company ended the quarter with approximately $1,142,000 in cash and cash equivalents, down from $3,022,000 at September 30, 2015. Subsequent to the quarter end, the Company announced its intention to privately place approximately $2.5 million of unsecured senior debentures convertible into common shares at a price of $1.25 (“the Debentures”). The Debentures bear interest at 12% and come due May 31, 2018. Management has reviewed its projected funding requirements and expects that, through the generation and collection of revenues and/or raising additional financing, the Company will maintain sufficient liquidity.

Outlook

Management continues to believe 2016 will be another record year for Nanotech, with our goal to again double our annual revenues. We anticipate demand for our security features will continue to grow, and we expect to achieve significant progress in the development of our customer channels and continued commercialization of Nanotech’s KolourOptik® technology. Production volumes are expected to ramp up through the summer to continue to supply this customer with significant colourshifting OTF through 2017 and beyond.

Achieving these results is not certain and involves known and unknown risks that may cause actual results to differ materially from this goal. These risk and uncertainties include, among other things, risks related to: uncertainty of amount and timing of purchase orders, the ability to complete a definitive agreement with the planned European co-production partner, market acceptance of KolourOptik® technology and our ability to maintain sufficient liquidity through March 31, 2017 to facilitate any business ramp-up. These and other risk factors are further discussed under the “Business Risks and Uncertainties” segment of the September 30, 2015 MD&A.